Deck 13: Financial Futures Markets

Question 1

The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.

Answer 1

True

Question 2

Interest rate futures are not available on

A)Treasury bonds.
B)Treasury notes.
C)Eurodollar CDs.
D)the S&P 500 index.

Answer 2

D

Question 3

A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.

A)increase; gain
B)increase; loss
C)decrease; gain
D)decrease; loss

Answer 3

C

Question 4

According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as

A)cross-hedging.
B)ratio hedging.
C)basis hedging.
D)liquid hedging.

Question 5

The initial margin of a futures contract is typically between ____ percent of a futures contract's full value.

A)0 and 2
B)5 and 18
C)25 and 40
D)45 and 60

Question 6

Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.

A)increased; more
B)decreased; less
C)remains the same; more
D)increased; less

Question 7

The basis is the

A)difference between the price of a security and the price of a futures contract on the security.
B)gain or loss from hedging with futures contracts.
C)difference between a futures contract price and the initial deposit required.
D)price paid for a futures contract after accounting for transactions costs.
E)price paid for an option contract.

Question 8

Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.

A)adversely; purchase
B)favorably; sell
C)favorably; purchase
D)adversely; sell

Question 9

If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.

A)increase; selling
B)increase; buying
C)decrease, selling
D)decrease; purchasing a call option on

Question 10

____ trade futures contracts for their own account.

A)Commission brokers
B)Floor brokers
C)Commission traders
D)Floor traders

Question 11

Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.

A)not allowed to be traded
B)are rarely desired
C)are commonly traded
D)A and B

Question 12

A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.

A)option contract
B)brokerage contract
C)financial futures contract
D)margin call

Question 13

Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract?

A)$.50
B)$50
C)$500
D)$5,000
E)none of the above

Question 14

According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as

A)a long hedge.
B)a short hedge.
C)a closed out position.
D)basis trading.

Question 15

Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?

A)$1,180,000
B)$118
C)$11,800
D)$15,625
E)$1,562.50

Question 16

____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices.

A)Hedgers
B)Day traders
C)Position traders
D)None of the above

Question 17

Futures exchanges take buy or sell positions on futures contracts.

Question 18

The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.

A)higher
B)the same
C)lower
D)higher or the same

Question 19

The use of financial leverage

A)magnifies the positive returns of futures contracts.
B)magnifies losses of futures contracts.
C)both A and B
D)none of the above

Question 20

If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.

A)increase; be unaffected
B)decrease; be unaffected
C)A and B
D)decrease; decrease
E)decrease; increase

Question 21

The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is

A)$700.
B)$7,000.
C)$3,190.
D)$3,120.
E)$3,500.

Question 22

Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.

A)receivables; appreciation
B)receivables; depreciation
C)payables; depreciation
D)payables; appreciation

Question 23

A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid

A)the gain on the futures contracts offsets the loss on the mortgages.
B)the gain on the mortgages offsets the loss on the futures contracts.
C)the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
D)a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.

Question 24

Companies with international trade can hedge ____ by ____ currency futures.

A)payables; selling
B)receivables; buying
C)payables; buying
D)A and B
E)B and C

Question 25

Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund

A)liquidates its stocks whenever it expects a market downturn.
B)maintains a constant buy position in stock index futures.
C)maintains a constant sell position in stock index futures.
D)none of the above

Question 26

Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations.

Question 27

____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.

A)Market
B)Liquidity
C)Credit
D)Basis
E)None of the above

Question 28

Systemic risk reflects the risk that a particular event could

A)cause losses at a firm due to inadequate management control.
B)spread adverse effects among several firms or among financial markets.
C)cause a loss in value due to market conditions.
D)have a larger effect on the futures position than on the position being hedged.

Question 29

The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at

A)the settlement date.
B)the date at which the futures price reaches its maximum.
C)the date at which the futures price reaches its minimum.
D)the date three months beyond the date when the initial position was taken.

Question 30

If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.

A)smaller than
B)greater than
C)equal to
D)B and C are both possible

Question 31

The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be

A)equal to the prevailing stock prices.
B)below the prevailing stock prices.
C)above the prevailing stock prices.
D)negative.

Question 32

The prices of stock index futures

A)are always the same as the prices of the stocks representing the index.
B)are always a little above the prices of the stocks representing the index.
C)are always a little below the prices of the stocks representing the index.
D)none of the above

Question 33

In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.

A)less; greater
B)more; greater
C)more; smaller
D)none of the above

Question 34

Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.

A)would be; would be
B)would be; would not be
C)would not be; would not be
D)would not be; would be

Question 35

Which of the following statements is incorrect with respect to cross-hedging?

A)Even when the futures contract is highly correlated with the portfolio being hedged, the value of the futures contract may change by a higher or lower percentage than the portfolio's market value.
B)If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts.
C)The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
D)If the price of the underlying security of the futures contract moves closely in tandem with the security hedged, the futures contract can provide an effective hedge.
E)All of the above are correct with respect to cross-hedging.

Question 36

The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as

A)market risk.
B)liquidity risk.
C)default risk.
D)basis risk.

Question 37

Municipal Bond Index (MBI) futures

A)involve a physical exchange of bonds.
B)are based on a Treasury bond index.
C)are based on actively traded corporate bonds.
D)are settled in cash.

Question 38

If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.

A)purchasing; Treasury bonds
B)purchasing; the S&P 500 Index
C)purchasing; a Municipal Bond Index
D)selling; a Municipal Bond Index

Question 39

Trading restrictions imposed on specific stocks or stock indices are referred to as

A)index busters.
B)index options.
C)circuit breakers.
D)protective covenants.

Question 40

Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.

A)magnifies; reduces
B)reduces; magnifies
C)magnifies; magnifies
D)reduces; reduces

Question 41

Market participants who expect the stock market to perform poorly before the settlement date may consider selling S&P 500 index futures.

Question 42

A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified price at a specified date.

Question 43

Which of the following statements is incorrect?

A)Circuit breakers are trading restrictions imposed on specific stocks or stock indexes.
B)Circuit breakers guarantee that prices will turn upward.
C)Circuit breakers may be able to prevent large declines in prices that would be attributed to panic selling rather than to fundamental forces.
D)Circuit breakers may allow investors to determine whether circulating rumors are true.

Question 44

Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia's position in the S&P 500 futures contract is ____ percent.

A)-20
B)-10
C)25
D)20
E)0

Question 45

____ risk is the risk of losses as a result of inadequate management or controls.

A)Basis
B)Systemic
C)Operational
D)Prepayment

Question 46

If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.

A)more; decrease
B)more; rise
C)fewer; rise
D)none of the above

Question 47

Brokers commonly require margin deposits from their customers above those required by the exchanges.

Question 48

Since stock index futures prices are primarily driven by movements in the corresponding stock indexes, participants in stock index futures monitor indicators that may signal changes in the stock indexes.

Question 49

Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura's position in the S&P 500 futures contract is ____ percent.

A)-20
B)-10
C)25
D)20
E)0

Question 50

Financial futures contracts on stock indexes are referred to as interest rate futures.

Question 51

The futures price is mainly a function of the prevailing price of the underlying security plus an expected adjustment in that price by the settlement date.

Question 52

Financial futures contracts are rarely sold over the counter.

Question 53

A financial institution that hedges with interest rate futures is less sensitive to economic events than an institution that does not hedge.

Question 54

Purchasers of financial futures contracts usually know who the sellers are, and vice versa.

Question 55

Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as

A)day traders.
B)hedgers.
C)closed-end traders.
D)position traders.

Question 56

Which of the following is incorrect regarding organized exchanges trading financial futures contracts?

A)Organized exchanges establish and enforce rules for the trading of financial futures contracts.
B)Organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not.
C)Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
D)The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
E)All of the above are correct.

Question 57

The value of a stock index futures contract has little correlation with the value of the underlying stock index.

Question 58

Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as

A)day traders.
B)hedgers.
C)closed-end traders.
D)position traders.

Question 59

Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.

A)sell; loss
B)purchase; gain
C)purchase; loss
D)sell; gain
E)none of the above

Question 60

Stock index futures cannot be closed out before the settlement date.

Question 61

Settlement of stock index futures contracts occurs through delivery of the underlying securities.

Question 62

Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher's nominal profit? The par value of the futures contract is $100,000.

A)$1,030.00; profit
B)$1,030.00; loss
C)$1,093.75; profit
D)$1,093.75; loss
E)none of the above

Question 63

___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.

A)Dynamic asset allocation
B)Cross-hedging
C)Index arbitrage
D)Net hedging

Question 64

Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.

Question 65

Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for over-the-counter futures transactions.

Question 66

Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.

A)40; profit; $76,800
B)40; loss; $76,800
C)50; profit; $70,000
D)40; profit; $70,000
E)none of the above

Question 67

Which of the following is not a type of risk associated with futures contracts?

A)basis risk
B)liquidity risk
C)market risk
D)postpayment risk

Question 68

Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities.

Question 69

Stock index futures are priced ____ than the stock index itself.

A)higher
B)lower
C)either higher or lower
D)none of the above

Question 70

The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.

Question 71

__________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.

A)Credit risk
B)Control risk
C)Operational risk
D)Management risk

Question 72

A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:

A)a long hedge.
B)a short hedge.
C)a day hedge.
D)index arbitrage.

Question 73

_________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.

A)Speculators; hedgers
B)Hedgers; speculators
C)Arbitrageurs; speculators
D)Hedgers; arbitrageurs

Question 74

An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.

A)increase; higher; downward
B)increase; lower; downward
C)increase; higher; upward
D)decrease; higher; downward
E)none of the above

Question 75

Which of the following statements is incorrect regarding organized futures exchanges?

A)Organized exchanges establish and enforce rules for the trading of financial futures contracts.
B)Organized exchanges serve as market makers for futures contracts by taking positions in futures.
C)Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
D)The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
E)All of the above are correct.

Question 76

Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.